S&P's Sam Stovall says look beyond one-day downturns to see the bull market still has legs.
Nancy Zambell: My guest today is Sam Stovall, the Chief Equity Strategist for Standard & Poor's Capital IQ Equity Research. Yesterday we had quite a day in the market, did we not?
Sam Stovall: Oh, we sure did. It started out looking as if it was going to be another up day that surprises the bears, who have been calling for at least a pullback in an attempt to digest some of the gains that we've experienced.
And then their fondest hopes came true as the Dow declined more than 200 points and the S&P fell more than 25. So now investors are wondering, "What next?"
Nancy Zambell: What are your thoughts as to why that actually happened? I had looked at the market at about 2 p.m. yesterday and it was up 20 or so, and then I go back again and oh my gosh. What I read is it's about the Italian elections...but do you have any thoughts beyond that?
Sam Stovall: I think most people had been examining what's going on here in the States and seeing that the sequester is going to be coming due on Friday, March 1.
Everybody pretty much acknowledges how dysfunctional the US government is. But investors were taking it in stride, expecting Congress to come up with an eleventh-hour or maybe even a midnight-hour resolution. Or even if we do end up locking in some budgetary cuts, that in the subsequent weeks we would come to some sort of resolution that does not cause all $84 billion to come out of the budget.
But I think investors were not expecting for the political makeup in Italy to be just as confusing and dysfunctional. And when they saw that there were a lot of votes being cast for the parties that said that they would not be supporting the austerity plan that Mario Monti had put in place over a year ago, I think that caused investors to worry, "Oh, no. Here we go again," in terms of the European debt crisis.
Nancy Zambell: It just seems like a replay of what happened with Greece when the voters rejected the austerity plan. So, what does that mean in the short term for us? Do you think we're just going to continue with this volatility until some decisions have been made?
Sam Stovall: I think that that's a likely scenario. US investors have had it pretty easy over the last year or so. We only experienced three days in which the S&P fell by 2% or more in a single day. Normally we have 15 per year, and in 2011 we had 21. Just based on the average since 2000, we had one-fifth the volatility that we normally do.
Also, I found that whenever the volatility has been very low in the trailing 20-day trading period that investors get a bit too complacent. When that happens, it no longer becomes a question of if, but when, we have a decline of 5% or more.
It appears as if we are now in that scenario where investors are giving back at least 5%, which would bring us down to around the 1,450 level on the S&P 500. And then we see where we go from there.
Our expectation is we think because the US economy will continue to expand as corporate earnings continue to rise, and because valuations look relatively attractive, this is a short-term bump in a longer-term upward trend.
Nancy Zambell: That sounds very positive. Are there any particular sectors that you think an investor could safely get into right now and hope to make some money in the next six months or so?
Sam Stovall: I guess the key word that you asked was "safely." We've been seeing some very strong, relative outperformance by the consumer staples group-the food, beverage, tobacco area. There's an old saying that when the going gets tough, the tough go eating, smoking, and drinking.
And if they overdo it, they go to the doctor. So, you could include health care in that category.
We also feel that once we move beyond this corrective phase that we could end up seeing the markets challenge the old high of 1,565 on the S&P 500. And once this decline is over and we do move back into a risk-on type of environment, then I would tend to say that the previous leaders-consumer discretionary and financials-would probably take a leadership role once again.
So, it really sort of depends on what your time horizon and risk tolerance are, as to how you would define getting back in safely.
Nancy Zambell: And you're still a believer in dividend ETFs?
Sam Stovall: Yes, I am, for several reasons. First off, companies that offer a dividend are quite prevalent. It's actually getting hard not to find companies that pay a dividend.
Nancy Zambell: Sure...when Microsoft (MSFT) started, it's like almost the world ended.
Sam Stovall: That's right. Now 80% of the companies in the S&P 500 pay a dividend. Two out of every three companies in the MidCap 400 pay a dividend, and nearly half in the SmallCap 600 pay a dividend.
I basically found that those five sectors in the S&P 500 that pay the highest dividends on average had the lowest volatility, as defined by average beta, whereas those five sectors that paid the lowest yield had the highest volatility. And remember, the less you lose, the less you have to make up just to get back to breakeven. So I find that dividends are still very important in an investor's portfolio.
That said, I think it's best not to yield to temptation, as I like to call it. Don't just buy yield for the sake of buying yield, because the valuations might not be attractive. You might be overpaying for that yield.
Specifically, a higher yielding ETF that I would recommend is the S&P Dividend Aristocrats (SDY). These are companies that have increased their cash payouts to investors in each of the last 20 years.
From December 31, 1999 through January 31, 2013, while the S&P 500 posted a cumulative total return of 30%, the Dividend Aristocrats posted a cumulative total return of more than 215%.
Nancy Zambell: That's very healthy.
Sam Stovall: So while past performance is no guarantee of future results, it basically implies that what you are doing is what Ben Graham, Warren Buffett, and other value-oriented investors tell you, and that is focus on quality.
Focus on those companies that have increased their cash payouts to investors, increased their earnings, pay a nice dividend yield, etc., and they are the ones who will likely reward you down the road.
Nancy Zambell: And you'll also be a little more of a conservative investor and be able to sleep at night.
Sam Stovall: Absolutely, because in 2008 the Dividend Aristocrats declined 22% while the S&P 500 fell 37%. And we might know the old adage that if you lose 20%, it takes 25% to get back to breakeven. But if you lose 50%, it takes 100% to get back to breakeven.
Nancy Zambell: That's a frightening statistic.
Sam Stovall: Oh, it certainly is. And everyone seems to say, "Yes, I can handle volatility," when it's not occurring, but end up panicking when even the slightest of volatility returns.